Monday, January 31, 2011

Shelter Realty, formerly Midcoast Realty, continues to provide clients with thoughtful and clear guidance to both buyer and seller clients in this turbulent market. Recent transactions include owner builders, foreclosures, custom timber frame homes, 200-year-old homes revived to be put on the market, raw land and more. With all of these come the abrupt starts and stops caused by lenders. This is a market where buyers and sellers alike have to hurry up and wait regardless of their particular debt-to-income ratio or property value. The climate of lending and borrowing money has gone through tremendous transition in the last five years and continues to evolve. However, no matter how a loan is packaged there are some golden rules that seem to be timeless.

I recently worked with a real estate client interested in selling their home. I conducted a Comparative Market Analysis (CMA) to determine the home’s current value and provided a price range of $150,000 to 200,000. The seller’s purchased their home in 2000 for $160,000 and at closing had a principal of $152,000 on a thirty year fixed rate mortgage with an interest rate of 8.07%. Their monthly mortgage payment was $1,122.75. In 2031 their mortgage would be paid, and they would have paid $252,189.42 in total for the house. However, in 2003, the couple refinanced to get a lower interest rate. The property was appraised and valued at $233,000. In 2007, the property was appraised at $281,000 when they borrowed an additional $30,000 against the house to do some needed improvements, including a new roof and siding. They refinanced one last time in 2008. Unfortunately, at that time the property was appraised at $180,000; the value dropped an astonishing $100,000 in just one year.

We have read similar stories all over the news. The interesting thing about this case is that the homeowners did not totally over-extend themselves. They are gainfully employed and paying their mortgage. All looks well on the surface. However, when I dug a little deeper, I found that because of the drastic drop in the home’s appraised value – which was reinforced by the bank when the homeowner re-financed their property – they are now paying very little toward their principle with each mortgage payment. The monthly payment is now $1653.59 with $365 toward principle and $925 toward interest. The result is that it will be virtually impossible for the homeowners to get out from under this mortgage even if they make payments perfectly or even slightly ahead of schedule.

My first inclination was to look at the history of the loan to see where it originated and whose hands it passed through. Interestingly, it started at a small community bank, but it was quickly sold on the secondary mortgage market – a requirement of Fannie Mae Mortgages. With the sale, the homeowner lost the personal touch of the small local bank and the brick and mortar bank front in which they could ask questions and troubleshoot their situation. However, the homeowners actively pursued their loan and their ability to satisfy it. They were told by the current underwriter that the only thing they could do for relief is file bankruptcy and let the home go into foreclosure or sign up for a government funded program. They signed up for the government-funded program, which is called “Making Home Affordable.” They were placed on a waiting list that was actually damaging to their credit score. While they were on the waiting list they were permitted to pay a lower monthly payment, but the lender is so large that the collection department was not aware of the permitted lower payment. The collection department began charging interest on the unpaid amount of each monthly mortgage payment (in addition to the accruing interest on their principal). Clearly their current lender was not engaged in being part of the solution. So at this point in the conversation, I introduced them to a couple of thoughtful local finance authorities to see what the home owner’s options really are and what their best course of action might be. The local bank with whom we spoke could do very little to assist, aside from encouraging them to get their credit report as clean as possible (by getting rid of all credit cards and stray debts) and come back in a few months to see if the local bank could buy the loan back from the larger bank.

What’s the point of outlining the mortgage rollercoaster ride these homeowners endured? Think about how much debt you’re willing to leverage against the potential value of your home and personal income.

How much debt should a typical homeowner take on? The magic numbers are no more than a 36% debt-to-income ratio with an absolutely worst case high of 41% debt-to-income under certain circumstances. Another good rule of borrowing and finance is to try to work with a local lender with whom you can communicate. Ask if your loan will be retained or if it will be sold on the secondary mortgage market. It’s much more difficult to communicate with a behemoth mortgage servicing giant than with Cathy who’s your neighbor.

What about your home’s appraised value? It’s impossible to predict future home values. Value is a relative term – in real estate it is defined as the dollar amount that the buyer is willing to give and the dollar amount that the seller is willing to accept in exchange for title. In a cash deal this number is determined by those two parties. Most real estate transactions are financed by lenders and this figure is then determined by market saturation, insurance valuation, tax assessment, and to a lesser degree real estate agents and replacement or reproduction figures.

Finance has changed drastically in the past couple years, but a few rules of thumb are still valid:

Don’t over extend: keep your debt to income ratio no greater than 41%(debt) to 59% (income) and 36% (debt) to 64% (income) is safer.

Be conservative. Maintain a 25% cushion on construction or renovation loans. When you estimate how much you need to complete a project, always add 25% to ensure you have enough. You can always use that extra cash to begin paying down the loan.

Locally held loans offer brick and mortar service centers from people who will take your phone calls and provide you with answer.

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Shelter has been teaching energy efficient, environmentally friendly, cost effective housebuilding since 1974. The Shelter Blog is a newsletter to keep you up to date on our latest class additions, timber frame projects, and woodworking tool reviews.